Four Lessons Discussed - Weekly Blog # 877

 

 

Mike Lipper’s Monday Morning Musings

 

Four Lessons Discussed

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 Farmers’ Experience Led to the Crash

Is 1930 a preview of 202x? To set the stage, the 1920s were a period of transition and economic expansion. America and most of the industrial world enjoyed meaningful economic progress spurred on by the encouragement of increased debt. Governments, companies, individuals, and farmers used the resources of others to leverage their assets with increasing debt, fulfilling their perceived needs at ever increasing rates. The lessons of the 50-years before WWI were distant memories.

 

Due to WWI mobilization, women entered the workforce in increased numbers. The returning military found farm work too hard and too poorly paid on the farms. Financial communities, which had extensive experience with debt and leverage, found vast new markets for the financial skills of banks and others. Thus, the missing manpower was replaced by expensive machines and chemicals, which led to farmers owning leveraged machines and farms.

 

The age-old problem with leverage is the cost-price spread abruptly narrows. In a world becoming increasingly more global, international trade becomes the fulcrum-point of the fluctuating cost-price spread. To protect those in the middle from price swings, tariffs and other restrictive measures were introduced.

The US consumer desired ever-increasing amounts of food, with much of it imported from lower cost countries. To protect home-grown crops, additional costs and restrictions were placed on imports. Exporting countries fought back by lowering their prices to a point where domestically produced products could not compete effectively. Consequently, domestic farmers got their elected politicians to impose tariffs on imports, like the Smoot-Hawley tariff that President Hoover was reluctant to do. (It was repealed three years later) Other nations reacted by imposing their own tariffs on US exports, which was a contributing cause for WWII. 

 

What will be the impact of the proposed Reciprocal Tariffs being proposed? Despite what is being said, it seems unlikely consumers will avoid some or more of the cost.

 

Learning from Uncle Warren

This weekend Berkshire Hathaway (*) published its results for the 4th quarter and all of 2024, along with a well thought out discussion. The company has four main revenue sources for the heirs of its shareholders. Berkshire has total or partial ownership of over 180 private companies and a smaller but better-known portfolio of quite large publicly traded companies. They also have an increasingly large portfolio of short-term US Treasuries, which increase in value as interest rates rise.

 

The difference between what their insurance companies charge and their eventual payout is called a “float”. In the most current period all earnings asset categories rose, except for the holdings of the publicly owned securities which declined because of sales. The total portfolio rose and is selling very close to its all-time high. Considering the company announced it is being managed for the benefit of today’s shareholder heirs; it is extremely appropriate to occasionally reduce its near-term market risks. (It is worth noting, the remaining two lessons in this blog suggest caution is warranted.)

(*) Owned in Personal and Client accounts

 

The Leading Mutual Funds Suggest US Risk

Each week I look at over 1500 SEC registered mutual funds, as well as many more in the global world. Usually, a number of different drivers describe the leaders of the week.

 

The list below shows the investment objective assigned to the fund:

Precious Metals Equity           21.04%

Commodities Precious Metals      11.86

International Large-Cap Value     8.60

International Mid-Cap Value       8.54

Commodities Base Metals           8.34

International Large-Cap Growth    8.24

Commodities Agriculture           8.15

Warren Buffet, among others, is concerned that the US government may cause the value of the US dollar to drop.

The year-to-date winners are not investing in the US.

 

“Debt Has Always Been the Ruin of Great Powers. Is the U.S. Next?”

 Above is the title of Niall Ferguson’s article in Saturday’s Wall Street Journal where he introduces Ferguson’s Law, which was crafted in 1767. The law states “that any great power that spends more on debt service than on defense risks ceasing to be a great power.” According to the author, debt service includes repayment of debt and defense includes all costs to maintain the military. The US has just passed this milestone, but it would take an extended period to fundamentally break the Ferguson Law.

 

Working Conclusion

Be careful and share your thoughts, particularly if you disagree.

 

 

 

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Preparing for a Recession - Weekly Blog # 843

 

         

 

Mike Lipper’s Monday Morning Musings

 

Preparing for a Recession

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

             

 

Learning from Wartime

When US Marines embark on a troop ship, they are instructed to wear less than comfortable life jackets. This sense of preparedness was one of the things I learned as a Combat Cargo Officer training fellow Marines for potential conflict. This preparation for the probability of danger to our economy, including client and personal investment portfolios, is what I hope to highlight in this blog.

 

Recessions are inevitable because humans prefer optimism to pessimism, expanding debt to leverage the oncoming good times. Politicians have learned that it is not a good vote-generating strategy to disappoint voters with actions. This has been the strategy for a large number of US Administrations from both parties, where they increase private and public debt without building up reserves. Consequently, history suggests we have not repealed recessions, we just don’t know when they will occur. Furthermore, we don’t know if the oncoming recession will be cyclical and largely a correction in prices, or a more painful structural recession with significant businesses collapses requiring lifestyle changes.

 

Don’t Abandon Ship by Massive Selling, But Get Your Lifejacket Ready

As a midshipman in training on the Battleship New Jersey, I was assigned to serve watch as the sole crew member in the crow’s nest, the very highest point on the ship. I was to report anything I saw as dangerous by phone. At one point I saw some round metal objects that looked like tin cans through my binoculars and excitedly reported it to the deck officer. This caused some commotion. Luckily, the old Salt of the deck officer recognized me as a landlubber and didn’t put the ship in an emergency condition. He understood that it probably was a tin can and not an unidentified destroyer known to Ship sailors as tin cans. In viewing what may be ahead for markets and economies, I will remember my midshipman experience and be careful with my language.

 

This is What I See for You to Evaluate

• The Conference Board reported that the University of Michigan survey showed a large drop in its measure of Consumer Confidence. It came close to the low of 2020.
• Perhaps as a preparatory move, 100,000 tech workers have been laid off year-to-date. (I don’t know how many are still unemployed.)
• New capital goods orders (non-defense except aircraft), were expected to gain +0.1% but actually declined -0.6%.
• A number of large public companies are cutting employment by selling products or divisions. The interesting thing is the breadth of companies taking these steps: AIG, Morningstar, Interpublic.
• Several mutual funds that performed well in the first quarter have cut back holdings weighted over 5%. Some of the stocks cut back were Berkshire Hathaway, TSMC, and AIG. (All held in personal accounts.)
• In the latest week, 55% of the stocks on the NYSE rose vs only 49% on NASDAQ. Remember, the NASDAQ is considered more speculative than the “Big Board”. Only 38% rose in the latest Saturday WSJ list of weekly prices for market indices, currencies, commodities, and ETFs.
• Two well-established mutual fund management companies with long-term orientations are expecting dramatic changes. Capital Group expects to see a meaningful rise in price volatility. (If this happens, there will likely be a rise in direct trading between major institutions.)  The other group is Marathon, who is concerned about the expected growth prospects of all aspects of “AI”. There is not enough planned construction for all elements of AI and what is required for the rest of the economy/society. There is a need for innovation and increased efficiency.
• Year-to-date through June 27th, there were four investment sectors that produced average returns exceeding the +15.51% earned by the average S&P 500 Index fund. (You may be able to get the one day that is missing, which didn’t have much impact.)

 

Investment Peer Groups Performing Better than S&P 500

Large-Cap Growth    +20.42%

Science & Tech      +17.91%

Energy MLP          +17.69%

Equity Leverage     +16.29%

 

There were 1222 funds in these four groups.

 

Question: How are you going to recognize the next recession?

 

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The Most Dangerous Message - Weekly Blog # 837

 

         

Mike Lipper’s Monday Morning Musings

 

The Most Dangerous Message

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

   

 

       

The Most Dangerous Message is one ignored. It appears most institutional and individual investors are doing just that and are being rewarded for taking increased risks. The worst one can say about a professional is that they were unaware of a potential problem. Almost every major disaster has had a tiny preview of a small event/planned rehearsal, or a curious outsider identifying a possible future action.

 

I recently noticed the following observations pointing directly to a future major decline in market prices. The observations are in no special order. Most important at this level of analysis is whether the expected coming recession is secular or structural. A structural recession is usually driven by the mistakes made by those in authority reacting to a secular recession, who then turn it into a structural recession as FDR did.

                  

 Observations That Could Predict Problems

1. Deere reduced its full year outlook due to soft demand for farm equipment. (In the 1920s many sectors leveraged their capital equipment expenditures. The farming sector was the first to “top out”. This caused many local farm banks to fail, which in turn strained regional bank resources. Today the farm sector is a much smaller percentage of GDP, and banks are better reserved. I wonder if AI expenditures could run ahead of derived revenues today, and more likely in the future.)
2. We are in a phase where numerous CEOs are being replaced. Others will likely follow, with many of the replacements wanting to establish themselves as effective change agents. This translates over time into massive spending. This week a new CEO of Vanguard was announced. Based on his history at BlackRock and a prior period with McKinsey he is likely to be a spender. The risk is that some of his new efforts, at least in the earlier years, will not be cash positive. JP Morgan Chase will likely be finding a replacement for Jaime Dimon’s twin roles. I wonder if the board will initially give her/him the same latitude Jaime earned. While Greg Abel has been promoted to the number two position at Berkshire Hathaway, he is much more an operator than Charley Munger, the former great number two. I suspect the new number two will move up to CEO, pushing some of the more than 60 chiefs of the operating companies to be more aggressive. While Goldman Saks’ stock is flying this year, the number of senior partners leaving suggests they are not a totally happy shop. It would not surprise me if David Solomon was to divide both the Chairmen and CEO positions within 5 years. (The securities of these companies are all owned for clients and personal accounts). While it is never wise to attempt to copy a successful investor, one can learn from some of their actions. Warren Buffet, an enthusiastic investor in Apple*, cut some of the number one holding in his portfolio. He is afraid of a sharp increase in capital gains tax rates and is not alone in having this concern. Others are additionally worried about income taxes, death taxes, and corporate taxes. Chris Davis, the CEO of Davis Funds, recently sold a portion of the group’s largest holdings, mostly financials. (I briefly worked for his dad when we were both at the Bank of New York). * Owned in personal accounts
3. This week there were approximately 3 times the number of index puts than the prior week, while the volatility index (VIX) was roughly 60% of what it was a year ago.
4. Only one stock market index fell out of the 32 indices produced by S&P Dow Jones, the UK Titans 50 Index. It only fell 0.30%.
5. The spread between the best and worst performing indices was much narrowed than usual, +2.97% vs -058%. Not much of an opportunity to successfully trade in what was thought to be a good environment after the indices hit record levels.
6. Industrial products prices on a year-to-date basis rose +5.66%, while employment cost gained +4.83 %. Perhaps the next stop is somewhere between the two.
7. According to the WSJ, since 2020 teachers have become more lenient, allowing grades to rise at the very same time test scores were dropping. This could be a contributor to productivity falling and the inability to find qualified workers. The military is also struggling to enroll needed forces.
8. China’s economy is rising at roughly twice the US rate.
9. Moody’s noted that opportunistic issuers took advantage of tight credit spreads. I wonder if rates rose while real fundamentals fell.

 

Please share the observations you think are important.

Notice to subscribers

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Mike Lipper's Blog: Trade, Invest, and/or Sell - Weekly Blog # 836

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Secular Investment Religions - Weekly Blog # 835

 

         

Mike Lipper’s Monday Morning Musings

 

Secular Investment Religions

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

   

       

Timing of Views

Apple announced its first calendar report this week, continuing a pattern of declining comparative quarters, albeit with a smaller percentage decline and slower sales of its latest iPhone model. Later in the week Berkshire Hathaway reported its first quarter results showing it sold 13% of Apple, its largest holding. During the Berkshire presentation I became increasingly concerned about the long-term outlook for US large-cap equities.

 

My worries were summarized in a column by Mohamed El-Erian for the Financial Times. He stated “tighter regulation, industrial policy, chronic fiscal looseness and internationally globalization has been giving way to fragmentation” as concerns.

 

Attending Berkshire’s annual shareholder meeting this weekend, I read a slide showing the major sources of the firm’s net operating income after taxes. One of the reasons to go to the meeting is that they report the results of the over 60 wholly owned and majority-owned companies in summary. In aggregate, their growth in earnings has slowed down or fallen. Most of these companies produce products and services used globally. Despite record domestic stock prices, it appears we are probably going to see an economic decline of measurable depth and magnitude. The questions that remain are timing and whether the decline is cyclical or structural. These questions forced me to examine the nature of these two remarkable companies presented this weekend.

 

Share Owners Create the Nature of Ownership

While management of the company largely dictates the nature of most companies, owners of the stock determine the nature of ownership of the stock. As both stocks are within ten percent of their all-time highs, there are very few losers in the stock. Both are multi product companies that provide services to both individuals and wholesale users. The companies have long outgrown their original set of products and services and their reputations allow premium positions within our society. While they have some competitors, they have no overall copycats. Their exact futures are not clear, although many users and owners have a great deal of faith in them, even though they don’t really know what their future will be. Without being sacrilegious, these two stocks have reached the point of being a religion in the secular world. Regardless of the existence of doubters and some heretics, it would take a major violation of the trust that has been established to destroy their faith in these two companies. (This has happened in the past, a couple of generations ago when the “Generals” were the secular religion, as in General Motors and General Electric, and many lesser Generals.)

 

Management Mistakes Admissions Help

Apple finally gave up on Project Titan (their car project). Elimination of their car project will allow Apple to conserve some needed talent. A complete car is a very different business and is not highly valued. Motorola lasted much longer, from its taxi and police car two-way radio in its early days to the semiconductor and early mobile phone years. On Saturday, Warren Buffet admitted he made the decision to sell Berkshire’s losing position in Paramount. While they were a supplier to Amazon, they didn’t buy the stock or another tech company until Apple.

 

Pulling the Thoughts Together Early

Revenue leverage in an inflationary period is unlikely to be maintained as a growth driver with small unit growth. Around the world, unit growth is decelerating. Productivity is also slowing because new hires are not as profitable as the seniors let go, even though juniors are initially paid less. However, lower pay expenses do not last long, as fringe benefits are more expensive, except for retirement. Retirees have not built-up enough savings to cover expenses in a non-work period. Productivity, where it exists, is driven by non-domestic born labor. Birth levels are below replacement needs and the education system is not producing ready, willing, and educated workers. AI gains, if delivered, will probably help the middle class but not the lower classes. The push for fewer working hours will create additional expenses and possibly social problems.

 

We need Berkshire Hathaway, Apple, and others to succeed for a healthy society around the world. Long-term it must be global, let’s hope it happens.       

 

 

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Preparing - Weekly Blog # 809

 

Mike Lipper’s Monday Morning Musings

 

Preparing

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 

 

Little did we know that nursery tales were preparing us to be sound investors. Remember the story of the three little pigs who all built homes, but only one survived the storms because he took the time to build with bricks.

 

Later, we grew up and found ourselves in a marching unit alert for the preparatory command, immediately prior to an execution order. We should always have been searching for preparatory signals to avoid major losses and unexpected gains.

 

Last week we warned that sudden rallies are usual in “bear markets”. Only time will tell if we have entered a bear market and if we should identify the following as preparatory signals. (What is your opinion?)

• Perhaps the soundest bank in Asia, DBS, was instructed by Singapore banking authorities to suspend various expansion efforts for 6 months.
• The leading banker in the US announced that he intended to sell roughly 12% of his ownership in the bank for estate and other reasons a year from now.
• In a private discussion, a CEO of a very successful private company bemoaned many companies for not being close enough to their customers to help guide them through the coming problems.
• Both Goldman Sachs and Morgan Stanley have reduced employment of talented people a couple times. A major large private investment organization has done the same.
• I went to an upscale department store looking for an appropriate business casual shirt in my size. The store only had small, medium, and large shirts, not the usual array of arm lengths or shirts with 2-inch variations. This brought home the statement by UPS that their package business from Hong Kong was down because retailers were reducing inventories.
• Panera just announced that is laying off 17% of their workers before they do an IPO. There has been an increase in mergers, but most of them are stock for stock deals. This is a sign that cash is too expensive, and their own stocks are no longer cheap.

 

Preparing Oneself

Marcus Ashworth is a brilliant columnist, which means that I agree with him. He wrote “Probably the most underrated skill in finance is knowing when to sell”. It may be wise to first identify what to sell. I suggest the first step is to identify each holding in terms of purpose, as either speculation or investment. The main difference between the two is whether your bet is based mainly on the belief that the price will rise. Or alternatively that earnings will grow, new products/strategies will be launched, new leadership will be in place, or there will be a closing or a collapse of principal competitor.

 

The next step is to find or create an appropriate peer group. (This is easier for mutual funds.) Then, in the shortest reasonable time-period, arrange the peer group into quintiles. (Caution, avoid dividing the peer group into quarters or halves.) If the peer group you are studying is a narrow-based specialty, your best bet is to be in the top or bottom quintile. If it is in the bottom quintile you are betting on the changing character of your investment making it a winner. These types of securities normally do best for brief periods.

 

I follow a different approach for diversified equity holdings. My approach is less volatile than the general market and spends most of the time in the second or third quintile. It is rarely in either of the extreme performance quintiles. These placements are appropriate for long-term holdings with periodic payments to beneficiaries and has the benefit of keeping clients happy and maintaining relationships.

 

When to Sell

The biggest risk for many long-term investors is impatience, which was noted by Blaise Pascal in the 1600s. He said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” This sitting approach works better with large portfolios of high-quality stocks, because over time the gains will be greater than the losses, particularly during inflationary periods.

 

We are quite possibly not in such a period. Charlie Munger recently commented that during Berkshire Hathaway’s (*) first four decades of Warren Buffet’s ownership history it was relatively easy to pick sound investments. In looking at the company’s 3^rd quarter report there were a considerable number of subsidiaries whose earnings were disappointing, but the success of their larger positions more than made up for those that declined. (They have built up a very sizeable cash reserve in anticipation of finding good future homes for their acquisitions.)

* Owned in managed or personal accounts

 

Outlook(s)

The longer-term outlook is quite attractive, with IBES estimating S&P 500 earnings per share reaching $276.02 in 2025 compared to $218.09 in 2022. The current concern about corralling the rate of inflation does not seem to be an issue with 30-year US Treasury paper yielding 4.75%, not much different from the 10-year rate of 4.56% and the 2-year rate of 4.83%. (I suspect that there is considerable amount of leveraged buying of 2-year compared to the 30-year, which is one of the reasons shorter rates are higher.)

 

However, the reason for discussing multiple outlooks is the shorter-term future looks more troubled than the longer. If one treats the period since the beginning of COVID-19 as a single unit, we have been going through stagflation with volatility. One of the reasons the stock market has done as well as it has is due to an increase in leverage, both operational and financial. Revenues have been going up marginally, but reported and adjusted earnings have risen by a multiple of sales. This resulted from an increase in private debt and other forms of debt extensions driven primarily by large caps. (In the latest week, declines represented 1% of the companies traded on the NYSE vs 23% on the NASDAQ). I previously alluded to the number of middle size companies owned by Berkshire not doing as well as in the past.

 

There were contradictory indicators delivered this week. On Saturday the WSJ reported that 90% of the weekly prices of securities indices, commodities, currencies, etc., were up. The sample survey of the American Association of Individual Investors (AAII) had 50.3% bearish over the next 6 months vs. 24.3% that were bullish. The bearish reading is not only twice the bullish, but entered an extreme reading and was much larger than it has been over the last couple of weeks. (It is possible that the sample skewed differently this week or participants reacted to the news.)

 

My Operating Conclusions Remain the Same

 

Some trouble ahead, with better markets in 2025. 

 

 

 

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Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

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We Allow Our Investment Professionals to be Lazy - Weekly Blog # 776

 

Mike Lipper’s Monday Morning Musings

We Allow Our Investment Professionals to be Lazy

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

  

 

 

The Indictment

Short-term investors are often confused with speculators. While they may produce the most trades, long-term investors own the most securities. This is why the financial media is jammed with views of short-term consequences, e.g., the next announced move and statement of the Fed.

 

Whatever the Fed does, the impact on long-term assets will be minimal at best. The key numbers for long-term investors in declining order of importance are:

1. The purchasing power in local currency at the planned terminal date.
2. An discounted valuation caused by a premature sale.
3. Third is the aggregate value of distributed income while the asset is held. This could conceivably be larger than the first case on very long-held assets in a generational transfer.

Most pundits would rather pontificate about near-term prices than speculate on the three long-term numbers which are difficult to guess and won’t be known until many years in the future. These very long-term guesses are however what owners need in selecting the current assets that should be owned. While it is almost impossible to determine the exact future valuation, it is possible to come up with relative value ranges. In many long-term portfolios there are bonds and other securities with contract relationships. What is far from certain is the price and value of these instruments.

 

Historically, possibly bigger but more uncertain returns are earned from risker equity investments than from more predictable bond-like instruments. Bonds are also characteristically less volatile, but can only possibly recover their face value plus interest.

 

Nevertheless, the lure of higher potential returns attracts investors to equities and with it higher compensation for the advisors involved. This is the ballpark I choose to play in. To do so I take the inherent risk of attempting to make reasonably accurate projections regarding the relative performance of various equities and equity funds.

 

The Playing Field

As most of our clients are US dollar-based investors my primary interest is in US activities and how non-US actions impact US beneficiaries. The following is a list of primary concerns I have about the future of the US from an investment perspective. These current conditions are rarely discussed by the popular pundits.

1. Productivity is declining, which means the US is producing less sales and profits for each dollar of investment or hours of work. Productivity translates into long-term price gains in the marketplace. In last week’s blog I noted that the S&P 500 Index had gained an annualized return of over 10% since 1871. Prior to Covid the S&P 500 rose 9% per annum. We are growing even less this year. Depending on which prediction you choose, the expected gain is between slightly above zero and 7%. My guess is that “social spending” by industry and government has cost us at least one percent. The FTC, reshoring, and energy policies are likely costing at least another 1%.
2. We have lost the drive to win a war and the related peace after our conflict in Korea, Vietnam, Iraq, and Afghanistan. Our military now has a social mission, not primarily a military mission. To win we must want to win. Our current military is underfunded and not structured to win.
3. Excluding immigrants, we like China, are not growing our native-born population. This is not going to help improve productivity. Before 2050 India will have the largest population and by the turn of the century, Nigeria and possibly another African country will likely be the leader.
4. We are likely to see a new generation of global political leaders, possibly with more authoritarian tendencies. US industrial and commercial leaders will also change.
5. US schools are producing a generation of students who do not want to work hard and effectively. Our leading STEM oriented universities will produce good managers for a while, although some of the best will leave. That is too bad. Note the number of top leaders who are foreign born or first-generation Americans. We shouldn’t lose these leaders, we need them to replace some of the current politically adept CEOs.
6. China is likely to remain the fulcrum of world growth, they work harder and smarter.
7. From an investment standpoint, private companies are growing faster than public companies due to leverage and incentives. Incentives eventually lead to these companies becoming publicly owned, which requires public markets to not be overly burdened by government policies.

 

Restructuring How We Do Things

(The following is just one example of what may occur)

Our medical/insurance complexes have become gigantic bureaucratic political bodies, where patients are cogs in a machine. For instance, a patient living in the UK who has been in remission for over 2 ½ years is likely expected to return to the East coast to see his doctor every six months. Why can’t he go to a UK medical location and electronically tie in with a US facility. If these types of arrangements can’t be worked out, the real estate implications are enormous.

 

These are the types of changes we are looking to invest in.

 

Brief Initial Thoughts on Silicon Valley Bank and Credit Suisse

Both were victims of their own business mismanagement, poorly informed clients, and poor government/industry regulation. I wonder in the long run if our society is better off letting them fail rather than partially bailing people out. I don’t know if the victims learn anything. More importantly, do investors in general learn to be more careful. I am most concerned by the last group.     

 

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Fundamental Changes Occurring - Weekly Blog # 755

 

Mike Lipper’s Monday Morning Musings

Fundamental Changes Occurring

 Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

            

 

 

People are changing their attitudes about what they do with their money and investments. Failing to define their changed concerns about the future, they are not happy. They appear to fear more fundament changes than just a relatively simple, shallow and quick, cyclical recession.

Without fully defining the cause of their fears, they are moving their cash and investment around slowly. Third quarter statements for leading commercial banks are showing increased deposits and the purchase of fixed income securities and loans. For their own accounts, leading banks are raising their bad debt reserves.

 

Liquidity

Jaime Dimond, the CEO of JP Morgan Chase, is worried about a possible future stock market decline of 20% due to credit concerns. Concurrent with liquidity concerns in domestic and international markets.

Most non-trading investors are unconcerned about the amount of capital on trading desks. This capital is needed to provide immediate support for transactions resulting from sudden and sizeable events. Last week, a well-known high-quality financial services stock had quite a day. After closing at $98.07 the prior day, it opened at $94.99 after a bad earnings report, then dropped further to $93.53 before rising to $102.66, finally closing at $101.96. Trading volume on the NYSE was higher by 1 million shares for the day. While the earnings report was less than expected, the closing price was roughly in line with prices paid over the past couple of weeks.

The price action of the stock suggests the NYSE market-makers did not have enough uncommitted capital to cushion the opening trade and early morning trading.

An indication market-makers are undercapitalized. This is a worry for all institutional sized investors owning shares listed on the “big board”.

 

Stock Strategy

Most of the time investors select stocks similar to each other, regardless of market capitalization. This is not currently true, with large-capitalization growth stocks leading the way since the June lows. However, smaller caps have been led by “value” stocks. This dichotomy is probably based on the belief that large-caps are more liquid than smaller-caps. Additionally, the average small cap value stock is cheaper in terms of price/earnings ratio.

However, if one sees the next market as essentially a recovery from the decline, you would be attracted to large cap growth, now selling under stock prices of two years ago. International mutual funds on average have three years of poor performance to recover from.

If you believe the next major move is a recovery, then large caps make sense. People currently find the low S&P 500 price of 3583.07 attractive. I am not such a believer.

Odds favor the next “bull market” having a largely different leadership than the last. In part, leadership will come from corporations positioned to be providers of products and services to a restructured world.

 

Public vs. Private Investments

Since the sailing ship days investors have profited from “carried interest” earned by ship captains and others on solid land. They benefitted from the price spread between what the owners of the ship paid for the merchandise and the price the captain negotiated upon landing. Carried interest is the source of wealth for Italian cities and Boston financiers nurturing the owner’s and captain’s wealth.

The same procedure was used by these firms when they invested in private companies. Boston law firms also used the same approach when they began investing in “privates”. (When I started visiting these law firms in the 1960s, they had more money under management in their trust-departments than mutual funds. They also had professional security analysts on their staffs.

Carried interest was used to connect portfolio people and salespeople with their wealthy families. The private equity business was founded through this union and grew significantly to include wealthy individuals and non-profit institutions.

Two other aspects beyond capital gains tax treatment aided their growth. A forty-year bond bull market generated capital to invest in private equity and private debt at very low interest rates. The privates also had a second advantage, their investors were trained to wait three to twelve months to see their investment returns. (By then their poor performance was not as painful as publicly traded investments reported with a one-to-ten-day delay.)

All of this is in the process of changing. There are now many providers of private funds with lots of spreadsheets. Interest rates have risen on leveraged capital. Many private funds are now investing in public securities and an investor or prospect can somewhat triangulate the private fund’s results. Private funds typically launch a new vehicle as soon as they can, often before the prior fund is fully invested.

I believe a handful of these funds will continue to produce good results. However, even these funds will be pressured by higher interest rates, competition for talent, and stronger negotiating people in operating companies. Only a few will produce exciting records.

 

Conclusion: Use dollar cost averaging to invest in good companies not already represented in your portfolio. The slower the better.

 

 

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/10/are-we-there-yet-weekly-blog-754.html

https://mikelipper.blogspot.com/2022/10/begin-to-dollar-cost-average-equity.html

https://mikelipper.blogspot.com/2022/09/if-not-bottom-then-what-weekly-blog-752.html

 

 

 

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